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Costly tax loophole remains open

Every year, wealthy investors and corporations avoid paying millions of dollars in property taxes in California by exploiting a large loophole in state law that homeowners are not allowed to use. Earlier this year, Assemblyman Tom Ammiano of San Francisco authored legislation that would finally close this loophole. But earlier this month, his bill, AB 188, stalled in the Assembly’s Committee on Revenue and Taxation.

Ammiano’s legislation is designed to change a key section of California’s tax code that currently allows some property owners to transfer interests in real estate without triggering a legal change in ownership. Avoiding an ownership change prevents reassessment of the property. Due to California’s Proposition 13, one of the only ways that property can be reassessed to reflect its actual value is when a change in ownership is registered. Thus, the legal loophole has allowed wealthy investors and corporations to game the state’s tax system for decades.

Ammiano recently pointed to the purchase of the Fairmont Miramar Hotel in Santa Monica to illustrate how Prop 13 and the tax code enable tax avoidance by the wealthy. In 2006, Texas billionaire computer tycoon Michael Dell bought the Miramar, but instead of personally buying a majority stake in the shell company that owns the hotel, Dell chose to add his wife and two other investors as partners in the deal. Because none of them individually obtained more than 50 percent of the holding company’s shares, a change in ownership of the Fairmont Miramar Hotel property was not legally triggered. The scheme kept the property’s assessed value at its 1999 appraised level and saved Dell about $1 million a year, according to an investigation by the Los Angeles Times published earlier this month.

Lenny Goldberg of the California Tax Reform Association said Dell’s tax avoidance strategy was a high-profile case, but that similar deals are executed all the time through clever legal maneuvers. Most fall under the radar of state and local authorities. "Partners in a company will sell significant stakes to their other partners and outsiders, and while the LLC that owns the property stays the same, the partners who own the LLC change," explained Goldberg. "Trusts and LLC are so common in real estate precisely for this reason, but it takes a lot of sleuthing through deeds to figure these things out."

Last year, Goldberg’s organization published High Tech, Low Taxes, a report highlighting the many ways Bay Area corporations dodge property taxes, including by using the change -of-ownership loophole. "Limited liability companies hold land for generations, avoid reassessment despite change in underlying ownership, and pay virtually no tax on highly valuable land," the report explained. It dug into tax assessments of vast tracks of Silicon Valley real estate owned and leased by corporations like Facebook, Google, and Apple.

The complexity of many deals, and the sheer number of real estate sales, allows many avoidance schemes to slip under the radar of assessors and appraisers. But even if most of the big avoidance deals were known about, it’s difficult to do anything because the letter of the law is currently on the side of those who want to game the system. In Dell’s case, the Los Angeles County Assessor went ahead and reassessed the property, prompting a lawsuit that has now tied the issue up in court.

Ammiano intends to eliminate this egregious loophole, but his bill’s fate is now in question. "Mr. Ammiano hopes to bring the bill to a vote later; meanwhile, there is a potential for some revisions," said Carlos Alcala, Ammiano’s spokesman. "We wanted to step back and see who else he can bring on board in the meantime."

Goldberg said he expects the bill will emerge from committee, but is unsure of a time-frame. In fact, this isn’t Ammiano’s first pass at the target; three years ago he introduced a virtually identical bill that was shot down by Republican opponents, and Democrats who worried about Proposition 13’s potential "third-rail" impact on their reelection prospects.

Even though the Democrats now have a super-majority in the California legislature, in addition to controlling the governorship and every other statewide office, many believe the party’s leadership lacks the courage to tackle tax reform issues. In April, Ammiano bucked this trend by publishing an opinion piece on Prop 13, saying "now is the time."

Goldberg agrees, and said that a broader coalition is forming to tackle Prop 13 reform and other tax issues that make California’s system of government finance inefficient and regressive. "We’re doing research at the county level in various parts of the state, and we expect to build enough momentum that, by the 2015 legislative session, all of this will be front and center at the agenda."

The California Chamber of Commerce, the California Independent Petroleum Association, the California Manufacturers & Technology Association, the California Taxpayers Association, and other lobbying groups representing major corporations and landlords who benefit from tax loopholes and low rates have opposed AB 188 vigorously. The chamber called it a "job killer" that will prevent investment in California real estate.

The Howard Jarvis Taxpayers Association, the lobbying group named after the author of Proposition 13, recognizes that some property buyers are gaming the state’s tax code in unfair ways. The group, however, also opposed AB 188. "What we need is enforcement of existing laws," said Kris Vosburgh, the executive director of the anti-tax group.

Most commercial real estate businesses operate using limited liability corporations and limited partnerships in California. These corporate forms provide considerable tax and legal advantages to property owners, one of which is the ability to mask changes in underlying ownership. In Oakland, Berkeley, and Richmond, thousands of office buildings, industrial sites, and apartment buildings are owned by LLCs and LPs, many of which are headquartered in Delaware and other states that provide complete anonymity as to who the true owners are.

"It has lots of other purposes as to why they hold things the way do," said Alameda County Assessor Ron Thomsen about the ubiquity of LLC and LP entities that own properties in the county. "But I would think it’s a benefit to the owners in terms of [property] transfers, too."